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A break-even analysis helps determine the point at which total revenues equal total costs

A break-even analysis helps determining the number of product units that need to be sold for a business to be profitable knowing the price and the cost of the product. It is crucial to understand the concept of fixed and variable costs to correctly calculate the break-even point during your case interview, but also in your daily work as a consultant. If the fixed costs are greater than zero, then it is important to have a positive contribution margin per unit (i.e. price>variable costs) to reach a break-even point at all.

A break-even analysis helps illustrate the relationship between profits, revenues and costs

Graph of the break-even point.

Because of the positive contribution margin, the slope of the revenue line is steeper than the slope of the total costs line. Therefore, revenue per unit is higher than cost per unit. If there were no fixed costs, then obviously the business would be profitable from the beginning. In the example shown above, the costs involved when zero units are sold are the fixed costs only. To cover these fixed costs, the business needs to sell a certain number of units to reach this break-even point or cover the fixed costs.

High break-even points usually suggest that a business could benefit from economies of scale

A detailed break-even analysis can provide some insight regarding the economics of a certain project or the entire industry. Imagine you come across a business that has a high break-even point since the business needs to sell a lot of products to become profitable (e.g., Intel). This scenario is usually due to large fixed costs (so called asset-heavy industries) which need to be covered by high product sales. In such situations economies of scale play a major role: The more units you sell the more you cover the fixed costs. In addition, due to the experience/learning curve you tend to have less variable costs and therefore more control over prices. Also, high fixed costs are a serious entry barrier for new competitors (see Porter's Five Forces for more details).

Apply the break-even analysis in weak profitability situations

For instance, your client is operating at increasing losses even though revenues have increased. You find that the issue is increased costs because of a newly opened factory. The additional fixed costs are still higher than the gain in revenues, leading to losses.

In this case, we can start by hypothesizing the need to increase revenues to fix profitability. In this scenario, it would make sense to check the break-even number of units sold before recommending increased marketing efforts. For a break-even analysis, you need to have information such as fixed costs, variable costs and price.

Required data

  1. Yearly fixed costs: $50m
  2. Average variable cost/product: $1000
  3. Average price/product: $1500

Calculation

  1. Profit/product: $1,500 - $1,000 = $500
  2. Break-even point
    • $500 * x units = $50m
    • x units = 100,000

As a result, the factory needs to produce and sell 100,000 units. Make sure to check its feasibility and if infeasible, your advice could be to divest the new factory.

Key takeaways

  • At the break-even point, a business has no net gain/loss.
  • To determine the break-even point, you will need a breakdown of costs and revenues of the product.

Apply the break-even analysis by solving this case: Clothing retailer marketing

Quiz

1
2
3
4
5
Abschließen Zusammenfassung

Die ausgewählte Antwort ist nicht korrekt.

Die ausgewählte Antwort ist korrekt.

Frage 1

Frage 2

Frage 3

Frage 4

Frage 5

Erneut versuchen
5 Kommentar(e)
24. August 2017 08:03 -
Neckers

Question 3 is misleading in my opinion. Specifically saying 20% of 'new profitts' implies, to me, I'll be receiving 20% of the 10k 'new profits' that are generated as a result of the investment. Question 5 also seems incorrect as someone else as suggested - 40/2.7 = 14.8

6. April 2017 13:12 -
anki

The answer of question No. 4 is not correct.

After 20 months the break-even will be reached. But the question was, when there will be a financial return. So no answer is correct.

The corrrect answer would be after 21 months.

18. März 2016 19:04 -
K

The Answer for Question Number 2 has a typo. The information under Option two states the "Revenue = $200 / license" when in actuality the Revenue = $20 / license.

7. März 2016 14:03 -
Anu

"new profit" is misleading - the "new profit" is only 10K so 20% of that is 2K however, the correct answer considers the total profit after the investment of 15K

24. Januar 2016 20:43 -
Jerome

14/ 2,7 is 14,81 therefore option d) must be right

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I think accounting break-even is enough because lots of candidates are from non-business background and may not know NPV, WACC, etc, and the interviewers know. They probably will not trick on this. Ho... (mehr)

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